2007-01-15

Low wages and the current account

1. An expanding and systemic current account deficit.2. The loss of low-skill work to overseas competition.3. The desire to reduce wages via legislation.

So, how to solve it?

Easy peasy. The best way to reduce the price of labour in an economy is to lower the value of the currency. In this case, reducing the value of the Australian and US dollars.

1. With a drop in the price of the currency, exports will decrease in value while imports will increase in value. Thus the current account will move into neutral or surplus.

2. With a higher demand for exports, there will also be an increase in the demand for low skilled labour. Thus low-skilled workers will get employment.

3. With a reduction in the currency, a de facto decrease in wages will occur.

So, how to decrease the value of the currency?

Option #1 - Create money and use it to buy overseas bonds. This will cause the value of the currency to drop (an increase in money supply). It will also lead to an increase in inflation, which will lead to an increase in interest rates.

Option #2 - Simply increase interest rates to reduce demand. This will lead to a rise in the value of the currency but will also result in a drop in economic growth. This, in turn, will reduce the demand for imports and put the current account into neutral or surplus. But, in order for this to happen, monetary policy needs to be stricter. It's always been my argument that zero inflation is the best monetary goal.